Convergence in Major Euro-Zone Stock Markets: Evidence from Monthly Data

Article excerpt

ABSTRACT

This paper investigates whether the introduction of the euro as a common currency promotes integration among the major Euro-zone stock markets. To carry out this investigation, the dynamics of the stock markets of Germany, France and Italy are studied. Monthly data on stock returns from February 1994 through December 2003 are employed. There is some evidence of increasing integration among these markets. Presumably, the post-euro sub-sample period may be too short to reveal the true extent of enhancing market integration.

INTRODUCTION

Eleven European countries introduced a common currency (euro) since January 1, 1999 replacing their own national currencies. They gave up their monetary authority to create the European Central Bank (ECB) that issues the euro and implements a common monetary policy for them. Adoption of the euro makes it easier for multinational corporations to design plans, pricing policies and invoicing. It eliminates exchange rate risk and facilitates the comparability of cross-border prices.

Reduced risk and lower cross-border currency conversion costs promote the flows of trade and investments among member countries and should bring about greater integration of Europe's capital, labor and commodity markets. Consequently, a more efficient allocation of resources is also induced within the region as a whole. Increased trade, in turn, has intensified Europe-wide competition in goods and services inspiring a wave of corporate restructurings including transnational mergers and acquisitions. The euro is thus expected to initiate necessary restructurings of the Euro-zone economy making it flexible, dynamic, productive, and better able to rival the mega U.S. economy.

Currently, governments of twelve Euro-zone countries can also issue bonds in euros, just as individual American states can issue dollar bonds. Likewise, Euro-zone corporations can issue stocks and bonds including other financial assets in euros. As a result, the euro is expected to enhance capital market convergence among the twelve Euro-zone countries. Although the full impact of Euro is yet to unfold, its effects have already been discernible.

The focus of this paper is the major Euro-zone equity markets and the issue of convergence using monthly data for the pre-and post- euro sub-periods. Since there is not a single European stock market, the main objectives of this paper are to determine if the euro introduction affects the integration of the above markets, and to determine if the integration has increased during the post-euro sub-period relative to the pre-euro sub-period.

BRIEF SURVEY OF RELATED LITERATURE

Many studies (theoretical and empirical) analyze the linkages among many national stock indices. If national stock markets were integrated, the lags of the price adjustments in these stock markets would be reduced (Koch and Koch, 1991). The empirical results usually depict significant correlation between markets in near geographic areas. The relaxation of controls on capital movements and foreign exchange transactions, improvements in computer and communication technology, expansion in multinational operations of major corporations, and above all globalization of financial transactions make stock markets increasingly synchronized and shorten the adjustment delays in international prices [Gelos and Sahay (2000), Jeon and Chiang(1991)].

There have been several studies about linkages and dynamic interactions among international stock markets with conflicting evidence. The results vary depending upon the choice of markets, the sample period, the frequency of observations (daily, weekly or monthly) and the different methodologies employed. Jafe and Westerfield (1985), Schollhammer and Sand (1985), and Arshanapalli and Doukas (1993) find substantial increases in the degree of international co-movements among stock price indices of the U.S., U.K., France and Germany excepting Japan. …